Madison Square Garden Stock Can Net Big Gains

By

Teresa Rivas

August 25, 2014

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Madison Square Garden sees its fair share of high-profile sporting events, but the real jousting may take place away from center court.

On Friday, a regulatory filing showed that John A. Thaler's JAT Capital Management had taken a 6.7% stake in Madison Square Garden (ticker:
MSG
), making it one of the company's largest shareholders. The Connecticut-based hedge fund stated in the filing that it planned to make suggestions for increasing MSG's long-term value, including changes in operations, strategy and management.

Shares rose 0.4% to $65.30 in mid-morning trading. Yet with an activist investor on board, there is more room for gains. MSG owns the New York Knicks basketball team, New York Rangers hockey team, MSG Networks and runs Radio City Music Hall.

The stock has risen following Steve Ballmer's $2 billion purchase of the L.A. Clippers in May, on the rationale that the Knicks would be worth even more in a sale. A major knock against MSG has been the belief that the controlling Dolan family would be unwilling to sell the team, even for a rich valuation.

While there's no guarantee that JAT Capital could force the Dolans' hand in that regard, the hedge fund's involvement will likely pressure the company to monetize the increasing value of its assets. This seems especially likely given that MSG's fiscal fourth-quarter earnings, reported last week, missed expectations. Sales, however, soared thanks to the Rangers' Stanley Cup appearance and higher event-related revenue. The sale of a more peripheral holding might allow MSG to keep its central assets while freeing up more cash.

With Sean Creamer becoming the new CFO as of Sept. 1, an activist investor could tilt the scales toward larger stock buybacks, which were largely anticipated after MSG's renovations came to an end.

Barron's was bullish on MSG's prospects earlier this summer, writing that the stock could climb to $100 on a new, more accurate assessment of the Knicks. (See Follow Up, "Madison Square Garden Shares Could Be Worth 75% More," June 14.) The stock is up 12.6% since that article's publication, a period in which the S&P 500 rose 3.3%.

At 26 times forward earnings, the shares aren't in bargain territory; however, a reevaluation of the Knicks' true worth could further lift shares, especially given that MSG's renovations have finally been completed.

Although MSG will always trade at a discount to its assets, given the dual stock structure that favors the Dolan family -- which also controls Cablevision (
CVC
) -- the value of those assets looks primed to rise. Barron's predicted the company could be worth as much as $7.7 billion, well above its current market value of $5 billion. Its long-term growth rate of 15% is above the industry average and it has no debt. While the stock doesn't pay a dividend, it does have an ongoing annual share repurchase plan in place, even if it isn't as large as some investors may want.

While MSG's assets are valuable, it has been criticized for its growth profile, and it's unclear how shareholders, including JAT, would react to an acquisition, as many investors expected MSG to be more generous in returning capital. It's not a Wall Street favorite either, garnering two downgrades before its most recent earnings report.

Yet activist investors and potential M&A aside, MSG Networks' licensing fees make it the most successful regional sports network in the country. It has a diverse set of revenue drivers and a profitable vertically-integrated model.

In a note Friday, Morgan Stanley's Benjamin Swinburne wrote that MSG's commitment to be more fiscally responsible means that the Knicks will modify payroll to avoid paying the luxury tax in fiscal 2016 and 2017, leading to as much as $35 million in adjusted operating cash flow in each of those years.

Sports fans aren't likely to be any less loyal in coming years than they have in the past. But betting on MSG's stock could provide the high of victory along with the more tangible reward of extra money in your pocket.

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